FX Weekly Update 25 Sep 2020

The Week in Review

The Aussie dollar experienced its worst week since March, falling 3.8% from its Monday afternoon high of 0.7323 to 0.7055 at time of writing. The likely reasons for this are twofold: continued muted risk sentiment, and new calls for an RBA rate cut in their upcoming October 6 meeting. Australian and US stocks are net up over the week, although US performance was more mixed.

AUDUSD Weekly Movements

Potential RBA Rate Cut

The key news event for the AUD this week was RBA Deputy Governor Guy Debelle’s speech on Tuesday morning, where among other things, he outlined additional policy measures the RBA could take to support the economy and achieve its mandated objectives.

These were:

1) To purchase government bonds further out across the yield curve, to complement the current yield curve control over the 3-year bond. Debelle noted however that this would have limited impact on domestic financial conditions, as in Australia not many instruments are priced off the longer dated tenors. There would be an FX impact though, which could support the economy through a lower AUD. Additionally Debelle said that “there is not… a trade-off between debt and supporting the Australian economy in the current circumstance”, meaning that the government does not require lower bond yields to finance their fiscal support.

2) To intervene in the FX market to suppress the AUD against traded peers. Governor Lowe has dismissed this in the past due to the historical evidence not looking favourably on central banks fighting against currency fair value fundamentals, and Debelle echoed this as well in his speech. He reminded the audience that FX rates are relative prices, and that the USD has declined against most of its major peers in recent weeks, along with Australia’s growth prospects looking better than most, and iron ore prices performing well.

3) To lower interest rates across the yield curve a little more, without going into negative territory. Debelle said that this could be done by cutting the cash rate, 3Y target, and term funding facility rates to a bit more (down from 0.25%).

4) To take the cash rate negative. Debelle again echoed what Lowe has said in the past, that the empirical evidence is mixed and that while there may be short-term gains via a weaker currency the medium-term effects can disincentivise consumer spending (and therefore lead to weaker growth).

The various interpretations from this speech from economists had a significant impact on the market, most notably from Westpac’s Chief Economist Bill Evans. Evans announced that their view was that the RBA would cut rates (cash rate, 3Y target, TFF rate) to 0.1% on October 6 as part of a coordinated “Team Australia” initiative complementing the Federal Budget (released the same day). Multiple banks believe that the RBA will instead sit on the sidelines in October, to assess the budget, and then act in November, but Westpac does not think that that usual approach is appropriate in the present environment. Despite their view for a cut, Westpac has maintained their AUDUSD forecast as 0.75 for the end of 2020, and 0.80 for the end of 2021

Federal Reserve Congressional Testimony

Fed Chairman Jerome Powell’s congressional testimony this week highlighted the critical need for more fiscal stimulus from Congress to sustain the US’ economic recovery, particularly for small businesses and the unemployed. While Fed policymakers pledged to keep interest rates near zero and ensure an accommodative monetary policy to help reduce unemployment, investors have become less hopeful that Congress will deliver another fiscal aid package like they were discussing before they went into recess for August. The partisan battle over the appointment of a Supreme Court Justice replacement after Ruth Bader Ginsburg has appeared to have sidelined the stimulus negotiations.

Potential Contested Election

There are growing signs that the US election could be contested, meaning that there might not be a clear President-elect for weeks or even months after the November 3 election day. This stems from President Trump’s objection to mass mailed voting ballots in multiple states, on grounds that it would lead to fraudulent votes. The potential for a contested election makes Ginsburg’s Supreme Court Justice replacement even more significant, due to how the interpretation of the voting results could fall to the Supreme Court. The Court’s ideological split prior to Ginsburg’s passing was even, but now that a replacement must be appointed President Trump will likely install a judge that flips the Supreme Court to a conservative angle. To avoid this, the Democrats want the justice nomination to be done after the election, but the Republicans do not want there to be a potential 4-4 vote if the election did end up in the Supreme Court (resulting in further indecision).

The Week Ahead

Key events to watch for next week:

First Presidential Debate – Wednesday late morning

US Manufacturing PMI – Thursday night

US Non-Farm Payrolls Labour Market Data – Friday night

References

Debelle, G., 2020. The Australian Economy And Monetary Policy. [online] Reserve Bank of Australia. Available at: <https://www.rba.gov.au/speeches/2020/sp-dg-2020-09-22.html> [Accessed 25 September 2020].

Finn, J., 2020. The Case Of Biden Versus Trump – Or How A Judge Could Decide The Presidential Election. [online] The Conversation. Available at: <https://theconversation.com/the-case-of-biden-versus-trump-or-how-a-judge-could-decide-the-presidential-election-146367> [Accessed 25 September 2020].

Condon, C., 2020. Powell Hints Small Business, Unemployment Aid Most Important. [online] Bloomberg.com. Available at: <https://www.bloomberg.com/news/articles/2020-09-24/powell-hints-small-business-unemployment-aid-most-important?sref=92Is2d7a> [Accessed 25 September 2020].

Evans, B., 2020. RBA To Cut Rates On October 6. Bulletin. [online] Westpac Banking Corporation. Available at: <https://westpaciq.westpac.com.au/wibiqauthoring/_uploads/file/Australia/2020/September/er20200923BullRBACutRates.pdf> [Accessed 25 September 2020].